We have all come through the financial crisis with a healthy respect for the destructive forces that are unleashed when modern finance goes wrong. Support for more effective regulation is on the ascent; our nation's determination to prevent any repeat of a crisis that brought the global economy to the brink is palpable.
Unfortunately, there is a real chance that America will go overboard in efforts to properly regulate banking organizations and that national and international rules and regulation will yield mindless rigmarole and underperformance. Images of financial train wrecks are so fresh in the public's mind that they create an impulse to punish honest mistakes as well as bad behavior.
Yet if we go too far, the stakes are high: A hobbled banking and financial system cannot be a vibrant and strong foundation for U.S. and global economic development and well-being.
The financial crisis is winding down, yet we remain in a phase of the policy debate where the pendulum has swung far past the center of gravity. For instance, though it is unpopular to say so, financial innovations in the last several decades helped in some ways to enhance economic well-being nationally and globally. Microcredit lending, securitization markets and, yes, even structured finance and trading activities are examples of financial innovations that can be harnessed for good, or squandered in fear.
Consider how the efficient transfer of wealth through our capital markets and improved tools of financial management have transformed the BRIC countries (Brazil, Russia, India and China) and improved economic health in parts of the Third World. Think about how, here in the U.S., modern instruments and markets have supplied the financing needed by technology and biotech industries that help power our economy. Imagine the opportunities that would have been denied to many low- and moderate-income Americans if modern financial approaches had not helped uncover creditworthy low-income borrowers.
The flagrant excesses of un- and under-regulated financial companies is no reason to stamp out innovations that change lives for the better.
Until the crisis struck, the sophistication of U.S. finance and capital markets gave this country an international competitive edge. However, this was not enough to counter the toxic effects of policies that encouraged consumer spending over savings, of failures to develop strong infrastructure and educational systems, of excessive national spending and of structural trade imbalances.
Modern finance may have made it easier for us to act on our worst impulses, but it did not create them. Railing against modern finance is a little like being against modern forms of transportation. When people are killed in plane, train and automobile crashes, the solution is to make transportation safer, not to bring back the horse and buggy.
There are, fortunately, ways that we can move forward.
First, we need rules and regulations to address market failures, but we must first analyze them to satisfy ourselves that they are effective and devoid of unnecessary burdens. For example, we need strong capital at financial institutions, yet excess capital puts a genuine drag on economic recovery, can be dangerously pro-cyclical and may well encourage risky behaviors.
Second, we should strip away rules and regulations that do not work or fall short. Unnecessary rules make financial institutions less safe and less able to fulfill their missions. The piles of mortgage disclosures that borrowers initialed did not prevent throngs of homebuyers from signing up for loans they did not understand and could not afford. In this example, the answer is not more disclosure but simplified, targeted, effective disclosure.
Third, we must tailor rules to the size of the institution affected and consider the issues facing our community and regional banking sector. Many smaller institutions are living with capital charges that are far higher than larger institutions'. We also have a strong bias against smaller monoline businesses, even small-business lenders.
Fourth, we need to increase professional opportunities for regulators, and training for young bankers and regulators. There are hardly any undergraduate programs — let alone graduate degrees — in bank regulation, risk management, compliance or other control disciplines.
Fifth, however high consumer protection standards are — and I they should be high — they should be national in scope and should encompass nonbanks as well as banks.
Sixth, we must solve the too-big-to-fail conundrum. For banks to expand geographically and in terms of product mix, society will demand that they be servants of the economy, not vice versa. If we do not solve this problem, banks will become public utilities, be broken up or ossify. Resolution frameworks before the House and Senate take strides toward a sensible resolution mechanism. However, these plans must incorporate all systemically important financial enterprises and not merely pick on banks.
Finally, the private sector must be responsibly involved in developing the framework and rules for a safe, sound, fair banking system. Though it is ultimately up to government to adopt and enforce the rules and to protect consumers of all economic circumstances, the private sector must do a great deal more to develop thoughtful inputs.
This is not a lobbying exercise; it is an exercise in study and effort.